Very late in the day on December 19, 2013, the Centers for Medicare and Medicaid Services announced a new approach to the problem of “cancelled” policies. CMS issued guidance permitting individuals whose insurance policies are “cancelled” and who consider replacement coverage to be unaffordable to apply for a hardship exemption from the individual responsibility provision of the Affordable Care Act. Individuals who qualify for this hardship exemption by reason of cancellation of their policies may then under the ACA purchase catastrophic coverage.

The problem of “cancelled” insurance policies has become a major headache for the administration. Millions of Americans have reportedly been receiving notices from their insurers that the insurance coverage they had previously purchased in the individual or small group market is no longer available. In most instances, coverage was not renewed because the particular policy form was no longer legal under the Affordable Care Act — because, for example, it excluded coverage of pre-existing conditions or failed to cover essential health benefits. In other instances, where coverage had been continuously in force since March of 2010, and was thus legally grandfathered under the ACA even though it did not comply with ACA requirements, insurers chose to cancel the policy which was otherwise legal.

These policy non-renewals have been widely misunderstood by the media. Under the Health Insurance Portability and Accountability Act, policies in the individual and small group markets have long been guaranteed renewable. Unless an insurer leaves a market altogether, the insurer must give an insured 90 days notice that it intends not to renew a policy and offer alternative coverage. I have seen no evidence that insurers have not been doing this. Individuals and small groups whose coverage has not been renewed are not being left uninsured; they are simply being offered alternative coverage.

In many instances, however, the coverage they have been offered by insurers is more expensive than the coverage that is not being renewed. In some instances, moreover, replacement policies not only cost more but come with higher cost sharing, presumably imposed to keep premiums from going even higher.

Part of the increased premium cost has undoubtedly been due to increased medical costs and to the aging of the policy-holder. A study also released on December 19 demonstrated that increased medical and administrative costs have been the primary factors driving significant premium increases in insurance coverage. In other words, even had the cancelled policy been renewed, it would have cost more.

But in many instances the premium increase has also been due to the fact that the insured was being offered more comprehensive coverage than contained in the not-renewed policy. Where premiums increased dramatically, a major factor has undoubtedly been the end of health status and gender underwriting; enrollees who had enjoyed a particularly low rate because of their health status or gender are now part of the general pool and are having to pay higher rates because others who have not enjoyed good health are paying comparatively lower premiums.

The increased costs facing Americans whose previous individual and small group policies have not been renewed has proven a political goldmine for opponents of the ACA, distracting attention from the implementation of the ACA just when the faulty healthcare.gov website has finally begun to function and many uninsured Americans are beginning to discover the affordability of coverage through the exchange. In fact, many of those faced with non-renewals seem to have in fact purchased the replacement coverage offered them by their insurer. Others have found acceptable coverage in the market outside the exchanges to replace their coverage that was not renewed.

Many others have apparently found affordable coverage through the exchanges. The recently released November exchange enrollment report notes that half of those who have qualified for eligibility to purchase a qualified health plan through the exchange will not be receiving premium tax credits. These are almost certainly higher-income Americans whose prior coverage has not been renewed, but have turned to the exchanges for affordable coverage. HHS stated, as it released its new cancellation policy, that the number of Americans whose coverage has not been renewed and who have not been able to find replacement coverage is a few hundred thousand, not millions.

The history of efforts to address the nonrenewal problem. The initial response of HHS to the nonrenewal issue was its “administrative fix,” announced in mid-November. Insurers were allowed, if permitted by their state insurance commissioners, to renew 2013 policies that had been in effect as of October, 2013, for another year in 2014. About half of the states have agreed to permit this. HHS has also created a special hotline (866-837-0677) to work with individuals whose policies have not been renewed and reports that it has been able to resolve about half the cases that have come to its attention, and is working with another third of the cases.

The policy announced on December 19, however, goes further. It provides that anyone whose policy is cancelled can apply for a hardship exemption, which, if granted, will qualify the individual to purchase catastrophic coverage though the exchange. Applicants must apply to the exchange for the exemption using the hardship application form and submit proof that their policy has been cancelled. They can then purchase catastrophic coverage, which reportedly costs about 20 percent less than bronze coverage. They will also, coincidentally, be freed from the ACA’s individual responsibility provision.

Catastrophic policies are available under the ACA to individuals under the age of 30 and to those who qualify for an exception to the individual responsibility requirement because they cannot afford coverage for less than 8 percent of their income, or because they qualify for a hardship exemption. The Secretary of HHS has discretion to identify hardship exemptions, and under existing regulations, HHS can grant a hardship exemption to an individual who has “experienced other circumstances that prevented him or her from obtaining coverage under a qualified health plan.” HHS has already exercised this discretion to define hardship very broadly, including allowing exemptions for those with high medical debt or those experiencing high costs in caring for an ill, disabled, or aging family member. There is no question about the legality of HHS exercising its discretion to declare a policy cancellation as another hardship category.

Whether or not this option helps a person facing cancellation depends on the circumstances. While catastrophic plans cost less than metal level plans, they are not eligible for premium tax credit or cost-sharing reduction payments. A person who is financially eligible for these forms of assistance therefore (or for Medicaid) could end up paying much more for catastrophic coverage.

Policy pros and cons. Whether the administration’s initiative is wise as a matter of policy is also not that clear. Insurers have reportedly protested loudly the administration’s decision. As a practical matter, it is unlikely that many of those who apply for the exemption will decide simply to drop coverage since they are no longer subject to the individual responsibility mandate. These are people who already purchased insurance without the mandate. The charge has been made that it is unfair to grant a hardship exemption to those whose coverage is being cancelled that does not apply to those who were not previously insured but also face high premiums. But many of these uninsured individuals will qualify for the affordability exemption or for one of the other hardship exemptions.

The most valid concern may be with allowing individuals who qualify for this exemption to purchase catastrophic coverage. The actuarial value for catastrophic plans in the exchanges — which have deductibles equal to the out-of-pocket maximum ($6,350 for 2013) but also cover three primary care visits and preventive services — is quite close to that of the bronze plan, 57 percent versus 60 percent. Insurers have priced catastrophic plans, however, assuming that the enrollees in these plans would be primarily young individuals, and they cost much less than bronze coverage. Catastrophic plans are also considered part of a separate risk pool for purposes of the risk adjustment program.

Allowing individuals with cancelled policies to purchase catastrophic policies is likely to cause problems for insurers who will now have to cover older and less healthy individuals through catastrophic policies priced for younger and healthier individuals. At the same time, however, the policy will siphon off individuals who were healthy enough to find affordable coverage in the pre-ACA market and who might have purchased non-catastrophic qualified health plans in the exchange. Insurers are already having to deal with later and possibly smaller enrollments than anticipated and the loss of some enrollees who would have enrolled in qualified health plans to renewed 2013 plans under the administrative fix. Taking this group out of the general risk pool for risk adjustment purposes will be one more blow to their actuarial assumptions, and possibly their solvency. They are understandably upset.

Basic Health Program payments. Finally, on December 18, 2013, the Centers for Medicare and Medicaid Services released its proposed 2015 methodology for determining amounts to be paid by the federal government to states that establish a Basic Health Program (BHP) under the ACA. CMS also published a notice of intent to collect information about silver and bronze plan premiums as needed to implement its proposed methodology.

The BHP is an alternative that states have under the ACA to cover their residents with incomes between 138 and 200 percent of poverty, who are not otherwise eligible for Medicaid, CHIP, or affordable employer coverage, through “Standard Health Plans” rather than qualified health plan exchange coverage. Federal funding is available to the states that adopt the BHP to cover 95 percent of the amount that the federal government would have spent on premium tax credits (PTCs) and cost-sharing reduction payments (CSRs), had the state’s BHP enrollees instead received coverage through the exchange.

The BHP was supposed to be implemented in 2014, but was delayed by HHS until 2015. The BHP has been considered as an option at one time or another by about a dozen states, but the delay in BHP implementation and the difficulties posed by implementing the current exchange program seems to have dampened interest in the program. Proposed rules for the program were published in September of 2013.

CMS intends to publish in October of each year a proposed payment methodology for the next following year (2013 for 2015), with a final methodology being published the following February for the next year (2014 for 2015). Obviously, this year CMS has been otherwise engaged and is behind schedule. A final methodology for 2015 will be published in March of 2014.

The proposed methodology addresses the problem of how to determine how much the federal government would have paid if BHP enrollees had instead received coverage through the exchange and claimed PTCs and CSRs. Under the proposed methodology, CMS has identified factors that determine the amount of PTCs and CSRs.

Under the proposed methodology, total federal BHP payments will be based on multiple “rate cells” for each state. Each “rate cell” represents a unique combination of age range, geographic area, coverage category (for example, self-only or two-adult coverage through BHP), household size, and income range as a percentage of the federal poverty level. There will be distinct rate cells for individuals in each coverage category within a particular age range who reside in a specific geographic rating area and are in households of the same size and income range. If a state does not use age as a rating factor, the BHP payment rates will not vary by age. States will report enrollment data on a quarterly basis to populate the rate cells, and federal payments would be based on the most recently reported data.

The proposed rate for each rate cell will be calculated in two parts, one consisting of 95 percent of the estimated PTC that would have been paid if a BHP enrollee in that rate cell had instead enrolled in a QHP in the Exchange; the second part equal to 95 percent of the estimated CSR payment that would have been made for BHP enrollees in that rate cell. These two parts would be added together to determine the BHP payment to the state for that rate cell, with total payments equaling the sum of payments for all rate cells.

PTC calculations would be based on the methodology used to calculate PTCs for individuals in the exchange, except they would be based on the mean expected PTC for individuals in a rate cell rather than be calculated on an individual basis. Payments would be based on reported reference premiums (second-lowest cost silver plan premiums for most individuals, bronze plan premiums for Indians) for the year of the payment notice, adjusted for 1) projected change from the reporting year to payment year, 2) BHP population health status, 3) the average net expected impact of income reconciliation on the combination of persons enrolled in the BHP (although BHP enrollees themselves are not subject to reconciliation). The health status adjustment reflects the fact that exchange premiums might have been higher or lower had the BHP population been covered through the exchange, but for 2015 will be equal to 1, since the BHP population will be included in the exchange for 2014.

CSR calculations will be based on the methodology used to calculate CSR payments for individuals in the exchange, except that they 1) will be based on mean subsidies that would have been paid for individuals in each rate cell, 2) reference second-lowest cost silver premiums (bronze plan premiums for Indians) adjusted for projected premium increases and a health status factor, and 3) reference premiums for non-tobacco users, adjusted for estimated tobacco-related costs for BHP enrollees. Administrative costs, determined at 20 percent of premiums, will be excluded from reference premiums in calculating CSR payments. On the other hand, reference premiums are adjusted upward in calculating CSRs to recognized additional utilization induced by the reduction of cost-sharing for the BHP population.

The proposed methodology defines each of the factors listed here and explains each of the calculations in considerable detail, as well as giving an example of how the methodology will work. These details are omitted here.